What is Loan Settlement? How Does it Affect Your Credit Score!

Published on Jan 21, 2022Updated on Sept 27, 2022

What is Loan Settlement? How Does it Affect Your Credit Score!

If you are thinking loan settlement is a positive development for your credit score as it results in loan closure, then think again. It’s exactly the opposite.

For any person, a situation of loan settlement arrives when he/she fails to meet the loan repayment obligations and is offered a one-time settlement option to close the loan account by the lender. However, there are many technicalities involved before the loan settlement takes place.

In this blog, we will focus on what loan settlement is, how it works, and its impact on the credit score.

What is Loan Settlement?

Loan settlement is also known as debt arbitration. It is an approach, through which both debtor and creditor come to a middle ground on the final loan settlement amount, which is less than the total outstanding amount, to close the loan account.

You should note, a one-time loan settlement option is offered to only those individuals, who are genuinely unable to make the loan repayment due to factors beyond his/her controls. For example, loss of job due to a slowdown in the economy, illness, injury, or some other reasons.

For lenders, it is a way to cut down the risk of further losses and for debtors, it helps to reduce the financial stress due to outstanding debt obligations.

How does Loan Settlement Work?

The one-time loan settlement option is not offered to all debtors. First, the lender needs to verify and confirm, the default happened due to a genuine reason that is beyond the control of the debtor.

Once the facts are established, the debtor is offered a one-time settlement option, in which the lender makes an offer to settle the loan in a single payment, writing off the interest rate and penalties. The amount depends on the repayment capability of the borrower and the severity of the situation.

If the debtor agrees to the loan settlement offer and makes the payment, the lender write-off the loan and the account is closed and is reported as “settled” to a credit information company, and in this case, CIBIL.

Must Read: How to Apply for a Personal Loan Balance Transfer?

How Does Loan Settlement Affect Your Credit Score?

Accepting a one-time loan settlement offer and repaying the loan amount along with interest within the due date are two different scenarios.

In the former, the account is recorded as “settled” and the later, the account is recorded as “closed” by the lender and reported accordingly.

Since loan settlement is not a normal closure of the loan account, and when “settled” is reported it is considered as a negative event and credit behaviour of the borrower.

Therefore, whenever “settled” is reported to CIBIL, it knocks off 75-100 points from the credit score of the borrower.

In such a case, it gets very difficult to get a loan for the next seven years, as CIBIL holds the information for seven years and is included in the credit report. Unless there is any drastic improvement in the credit score and finances of the borrower, the possibility of loan application rejection is highest.

How to Avoid Loan Settlement and Deal with the Situation?

A one-time loan settlement offer may look like an attractive option because of the reduced pay, but accepting the offer is not a financially wise decision. It should be your last option.

If you find yourself in this situation, where you are facing difficulty in repaying the outstanding loan amount, always look for alternative financing options. The following are the steps you can consider to repay the outstanding loan amount in full:

  • Using your savings and investments
  • Negotiating with the lender to restructure the loan or extend the repayment tenure
  • Or, taking a personal loan at favourable terms and repaying the outstanding loan amount in full  

Among the three options, availing of a personal loan to repay the outstanding loan to avoid loan settlement is the best option to go for. 

Through the personal loan eligibility calculator, you can know the eligibility, personal loan interest rates, and the maximum amount you can borrow. 

Also, you get the flexibility to choose the EMI amount as per your repayment capability. For this purpose, you can use the personal loan EMI calculator, where you can check the EMI amount of different repayment tenure easily.

Documents Required for Availing a Personal Loan

  • PAN Card
  • ID and signature proof
  • Proof of Address
  • Income Proof (Salary Slip, Form 16, ITR Filing)
  • 6 months bank statement 

Availing of the personal loan helps you in two ways, first, your credit score doesn’t take a beating, as you are paying the previous outstanding loan amount in full. And, second, you stand a chance to further improve your credit score, while repaying the personal loan. 

While taking a loan, ensure, you don’t borrow more than what is required and have an emergency fund to avoid such a situation.

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*Terms and Conditions apply. Loans are disbursed at the discretion of Fullerton India.

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